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We knew Telstra's core fixed-line (public switched telephony
network, or PSTN) revenue base was imploding - Telstra's chief
financial officer, John Stanhope, had said last month, at the
annual results briefing, that the PSTN revenue loss this year could
be twice the 3.4 per cent decline in 2004-05. Many thought he was
being conservative, given the acceleration in fixed-to-mobile
substitution.

Given the extraordinary 60 per cent margins in the PSTN, that
alone would account for more than $300 million of the $500 million
to $700 million decline in earnings before interest and tax Telstra
is now forecasting for this year.

We also knew a combination of regulatory decisions would have an
impact on Telstra's revenues and earnings, primarily in the old
copper core of Telstra's dominance. Telstra says that the cost of
regulatory decisions had been about $500 million a year for the
past two years and that this year the cost would increase to $850
million of lost revenue.

While Telstra said yesterday the decision to give the market
earnings guidance was prompted by its continuous disclosure
requirements, given that Trujillo had already warned that earnings
would be lower this year than last, and that Stanhope yesterday
reiterated his previous guidance that revenue would be marginally
higher than last year's despite the problems in the PSTN, it is
arguable there was no "event" requiring the disclosures.

That suggests yesterday's statement and briefing was more about
the politics of Telstra than its economics; that it was another
phase of the increasingly belligerent campaign to convince/coerce
the Federal Government into softening the regulatory regime it
proposes to introduce in tandem with the T3 process.

This is the final chance for Telstra to argue its case before a
new regime is locked in. It is prepared to risk antagonising its
political masters in order to weaken the proposed regime.

Telstra's problem is that the PSTN has passed a tipping point
and, regardless of the regulatory settings, will continue to
decline in the face of the shift of voice traffic to wireless.

The decline is being offset, to a degree, by Telstra's lesser
dominance of the lower- margin wireless sector but the growth in
wireless is competing away the growth and fat margins once
available there. The other great hope for Telstra is broadband,
where the growth is phenomenal.

To counter the loss of high-margin PSTN revenue, however,
Telstra needs to drive much bigger revenue gains in broadband.
Trujillo said yesterday that it would require $1.75 billion of
broadband revenue to offset the loss of PSTN revenue.

The urgency with which Telstra is mounting its case has probably
been driven by developments in the broadband market and their
interaction with proposed regulation.

Telstra has about 1.75 million broadband customers, split 50:50
between its own retail customers and those of other carriers to
which it provides wholesale access to its network. The wholesale
segment is, however, growing faster than Telstra's retail base.

Telstra knows there will be a point, which some broadband
offerers are achieving, where they will have sufficient customers
to make the case for putting their own equipment in Telstra's
exchanges and reducing the fairly generous access payments they
make to Telstra to a very modest line rental fee.

Hence the references by Telstra yesterday to two pending
regulatory decisions that it described as material - operational
separation and the pricing for unbundled local loop (ULL), which it
said included proposed ULL prices that were "de-averaged" and below
Telstra's costs. ULL access gives its competitors access to the
copper wires between a local exchange and the home.

Telstra now uses nationally averaged retail prices but
"de-averaged" wholesale access prices, which reflect the
substantial variances in the cost of providing services between
urban and regional areas. It would appear that Telstra now wants to
be able to average wholesale access prices as well.

The effect of a switch from de-averaged prices to averaged
prices would be to make it less attractive for its rivals to attack
its urban customer bases and more attractive to target regional
customers. Their lack of scale outside the more densely populated
areas and the less profitable character of the regional customer
bases makes that a proposition Telstra's rivals would not regard as
competitor neutral.

More particularly, raising wholesale access prices in
metropolitan areas while reducing them in regional Australia - and
retaining averaged retail prices - would create a price squeeze in
the cities which would reduce the incentive for Telstra's
competitors to install their own broadband equipment in Telstra
exchanges - it would protect Telstra's broadband revenue base and
prospects from the looming facilities-based competition.

Telstra has to do whatever it can to maximise broadband revenues
and margins to counter the probable decimation of its traditional
services. Staving off infrastructure-based competition would be a
triumph for the new team and preserve the hope of a higher-growth
and still-dominant future.

Despite the apparent sop of more competition in supplying
broadband to the bush, however, it is unlikely the Australian
Competition and Consumer Commission, Telstra's rivals or the
Government will find a policy that could undermine the competitive
provision of broadband to most Australians terribly appealing.

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